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a blog from young economists at Nova SBE

Ebay-nomics

Ebay is probably the largest internet auction site in the world. It is a market that brings together sellers and buyers all over the world, such that negotiation takes place through a bid-ask structure. The seller asks for a price, the buyer who gets the good is the one with the highest bid. Even though eBay has other features that are not based on a bid-ask structure, I will ignore them for the sake of simplicity.

Fortunately for economists, the bid-ask structure has a desirable feature: agents have perfect information. For instance, take a certain good that is sold by several sellers. In this market, every person knows the prices (bids) that are being charged for that good. However, a careful reader might argue that the seller knows more about the product than the buyer, which is actually true. However, eBay has a feedback system, where sellers are classified based on past trades, i.e any seller that tries to do some sort of trick to mislead a buyer, it will be classified as a non-reliable seller. Therefore, we can argue that no one will want to trade with a non-reliable seller. Consequently, sellers will have an incentive to behave well in equilibrium*.

Based on this it can be inferred that ,if every agent is rational, no one will bid on top of a good that think it is not worth the price charged. Neither any agent will trade with a seller that is classified as non-reliable. For these reasons,  many economists will argue that, under rationality, every good is well-priced, i.e the market is efficient. However, in reality, there seems to be quite evidence on inefficiency! On this issue, several economists proved that goods are not correctly priced in these markets, based on data from eBay and other online auction sites.Would this mean that economic theory does not apply to online auction markets? A lot of literature have been produced regarding this issue. I will present below some of the explanations formulated until now.

“The auction has 20 seconds to go…You are the high bidder…Yes! it’s yours! 10 seconds to go, Yes, it’s still yours! 3 seconds to go and you were outbid! What happened? You just got sniped!” – This is the explanation of eBay to point out snipping. This is one of the critics to efficiency on this market. The best strategy to the buyer is to bid on the very last second, leaving no chance for anyone to strike back. Thus, the final price is not its true valuation by agents, but rather the bid of the “sniper”. Considering the time at which this argument was formulated, I would have to agree. Fortunately, for economists, today this no longer applies. The reason is that eBay come up with a bidding system, where shoppers simply tell the maximum price they are willing to pay. Consequently, any sniper that tries to bid at the very last moment, eBay takes literally zero seconds to respond, outbidding the sniper.  With this new system, we can tell that efficiency was re-established! The buyer that gets the good is the one that has the maximum willingness to pay for it.

A much more stronger critic is what is called “bidder’s heat”, the statement that buyers will overbid their true valuation on the good, in some kind of temporary insanity, just like gambling. For instance, imagine you say eBay your maximum bid is $99 for a certain good. If someone else outbids you, eBay keeps increasing your bid automatically, but never exceeds your maximum. However, in those last seconds, you are outbid by $100. What happen next? On one hand, a rational agent faces this as a non-lose proposition. The maximum you were willing to pay was $99, so you accept losing the auction. On the other hand, an irrational consumer will think: “It’s all right to bid $101, I am just paying $2 extra to get that product”. In other  words, this points out one of the most frequent critics to economic theory: agents are not fully rational.

For the sake of this argument, Malmendier and Lee examined hundreds of auctions on eBay involving a game called “CashFlow 101”, a personal finance themed board game. Although the product could be purchased by $125, these two economists found out that, on eBay’s auctions, the starting price for the good was around $45, and impressively more than 40% of the time the auctions produced prices higher than $125. Later on, these same economists used the exact same approach with another product – iPod. It turns out that the results were very similar to the ones concluded before! Is there any explanation for this outcome, besides irrationality? If this is really an irrational behavior, will there be any predictable outcome, or it just means that the price of every good “goes with the flow”? Clearly, there is no consensus within economists regarding this issue.

Last, but not least, I would like to briefly discuss the role of eBay itself in this market. Probably it is not surprising for anyone that there are few competitors out there. Even if there is someone trying to appear with a service better than eBay, most people prefer to stick with eBay, because it is the largest market of buyers and sellers. If you want to sell something online would you sell it in a site where there is almost no buyers? Of course not! Your first idea is to sell it on eBay, because you know that probably you can sell it for a higher price. Guess what? eBay also knows that. Thus, it feels comfortable to charge a high commission for each trade, which is for sure a great source of inefficiency. Buyers and sellers will not state their true value for the good when incorporating these fees on their buying decisions.

Despite all the arguments presented, auctions remain important and elegant economic models, and the new research although it’s at an early stage, may ultimately help calibrate them.

Sources:

André Nunes, 705


* Although this system does not accurately solve the problem of information asymmetry, it can be shown that the only consistent outcome of this kind of trade is if sellers do not mislead buyers.

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Author: studentnovasbe

Master student in Nova Sbe

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